Two economists are walking along, and one of them says, “Look, there’s a hundred dollar bill on the sidewalk.” The second economist says, “It can’t be a hundred dollar bill; if it was, somebody would have picked it up by now.”

Most economists believe in market efficiency.  This belief requires a healthy dose of skepticism, which some see as cynicism.  That characterization is unfair.

Real Versus Rare

My family was staying at the Grove Park Inn a few years ago when we spotted what looked exactly like a Porsche 904 GTS in the motor court (photograph above).  It looked just like the mid-60s racing legend, with a short wheelbase, a very low roofline, and a detachable steering wheel (to assist getting in and out of the driver’s seat).  Convincing, but I knew it couldn’t be real; highly unlikely that anyone would drive such a rarity to dinner (about 100 were built), even on a beautiful day in the mountains of North Carolina.  A little research revealed it to be a kit car made by Chuck Beck – also rare but considerably more accessible than the original.

Last week we were surprised by an equally rare sighting, an S-1 filed by a prominent player in the RIA community.  Dynasty Financial Partners seeks to raise $100 million in a public offering.  The mercifully terse prospectus is less than 250 pages, and is recommended reading for anyone who swims (or fishes) in this pond.

The mercifully terse prospectus is less than 250 pages, and is recommended reading for anyone who swims (or fishes) in this pond.

As most of the readers of this blog know, DFP is the ten-year-old brainchild of Shirl Penney, Edward Swenson, and Todd Thomson.  The company provides a variety of services to both foundling and established RIAs, but principally engineered a plug-and-play back office for RIAs, sifting through the myriad of technology vendors needed for wealth management and organizing them on a proprietary platform called the Dynasty Desktop.

The pitch for potential clients is self-evident: RIAs of any scale can access the tech stack of a big firm on a subscription basis.  Dynasty stays on top of tech developments better than (most) in-house teams.

Complementing this is a TAMP and access to growth capital.  Being a Dynasty Network firm situates wealth management shops in a broader community of firms with similar interests, needs, and requirements.  Client firms get to focus on what wealth managers do best: stay at the front of the house, developing their business, while Dynasty manages the back of the house, supporting their business.

Great narrative.  DFP’s financials are promising, if lighter than expected.  Dynasty’s PR group is to be commended: the firm has developed an outsized prominence in the industry relative to its actual size.

Dynasty has a recurring revenue stream (most of its services are priced as basis points on AUA) and the scale of the business has more than quadrupled in the past five years.  Nevertheless, in the nine months ended September 30, 2021, Dynasty reported a bit less than $50 million in revenue and only $12 million in adjusted EBITDA.  While adjusted financial metrics sometimes warrant criticism, Dynasty’s reported EBITDA was only off $750K or so for the same period.

While full year financials aren’t yet available, we estimate run rate revenues of $75 million or more, with adjusted EBITDA approaching $20 million.  Dynasty’s unit economics are enviable, with a growth-plus-margin metric, so often cited by SaaS investors, of nearly 75% (period-over-period revenue growth of 50% plus an EBITDA margin of 24%).

What’s Not to Like?

As available investment opportunities go, Dynasty looks great except for one thing: it’s available.  Why is this hundred dollar bill on the sidewalk?  More specifically, why is a firm with this story and size not being funded by private equity?

There’s no shortage of private equity investors in the B2B, fintech, or RIA space; Dynasty should appeal to them.  As a B2B, Dynasty has a track record of attracting and retaining demanding RIA clients with their platform.  As fintechs go, DFP is certainly more interesting than the myriad of buy-now, pay-later startups that seem to attract nearly limitless capital these days.  Compared to the many PE-backed serial acquirers in the RIA space, this is an actual business…with products.  Surely, selling picks and shovels to RIAs is less speculative than being an RIA.

Surely, selling picks and shovels to RIAs is less speculative than being an RIA.

Why would management want to go public?  Running a public company is no walk in the park, and most management teams don’t choose that path instead of PE backing, especially with less than $100 million in revenue.   As such, we have a few questions:

• Is the Dynasty Desktop a comprehensive, proprietary technology solution for RIAs, or middleware that is easily replicable? The answer may depend on the client, but if it’s the latter, Dynasty is at risk of being exposed to more competition if the market for their platform becomes more visible.  Their offerings could be featurized by custodians or custom-engineered by developers.  The more success they achieve, the more competition they’ll attract.
• Is Dynasty’s fee schedule sustainable? We don’t have enough information to infer what Dynasty has been able to charge for their services over time, but current returns suggest a realized fee across all of their segments (tech stack, TAMP, etc.) of about 11 basis points.  The S-1 suggests that fees are negotiable, and larger RIAs probably pay fewer bps than small ones.  At the same time, Dynasty probably earns most of its profits from larger clients, because the base cost of service won’t be that different for a $200 million RIA and a $2 billion RIA.
• If the wealth management industry experiences fee compression, what does that mean for Dynasty? RIAs have the option of paying a consultant a one-time or infrequent fee to build a tech stack instead of regular subscription fees.  Smaller RIAs have an obvious incentive to get someone like Dynasty to handle the back-of-the-house stuff so they can focus on wealth management.  Larger RIAs can disintermediate and build their own margin with direct vendor relationships.
• What is normalized profitability for this company? Under the right circumstances, SaaS can throw off huge margins.  Here, the margin opportunity is hard to assess, although the potential for operating leverage is obvious.  Dynasty currently serves 46 firms with 75 employees.  How much additional headcount would it take to service 80 firms, and how specialized would those additional staff be?  We suspect that DFP’s move to Florida was part of an effort to right-size its cost structure.  While many rue the outflow of financial businesses from New York, we see it as both prudent and inevitable.  Being public, on the other hand, has costs of its own, and DFP will have to outgrow those costs to make the IPO worthwhile.
• What is the cost of remaining relevant in this space? It’s easy for in-house tech specialists to fall behind the competence curve.  When they do, companies lose opportunities, fall victim to malware, and profits suffer from inefficiency.  Outside tech providers can offer the latest and greatest and are pros at keeping themselves and their clients current.  But remaining current is expensive, and one wonders if a company the size of Dynasty can handle the tradeoff between the margin they make from today’s products and services and the cost of developing tomorrow’s products and services.  Dominant technology companies are either very niched or very large.

The Dynasty S-1 is mostly routine, except for one section outlining their efforts to remedy problems with their internal controls.  It’s probably nothing, but we’re surprised by this, as competent management of back-office issues is what DFP is supposed to be selling to RIAs.  If Dynasty could have waited a bit on their IPO, they could have cleaned up and avoided the disclosure.

Price Versus Value

So what’s the verdict?  It all comes down to price.  We know Dynasty wants to raise $100 million, and we estimate they have nearly $20 million in EBITDA.  How much of that EBITDA will $100 million buy?  We’ll soon find out.

It all comes down to price.

The Beck 904 is faster, more comfortable, and more drivable than an original Porsche 904.  It’s not “real,” but it’s real cool.  And the Beck is much cheaper than the original, priced at less than 5% of the auction value of the Porsche.  At $75K for a fully outfitted Beck and $2 million for the Porsche, each priced to reflect the underlying value of the car.